FinancialFutures

Exchangetradedcontractsforthedelivery(or
receiptofsomefinancialassetatsomefuture
time.
Theyare
Derivatives
Valueisderivedfromtheunderlyingasset

Usefulforspeculatingorhedging
Similartocommoditiesfuturesthathavebeen
tradedforcenturies

Examples
CBOT
30yrTbond
10yrTnote
30dayFedFunds

CME
13wkTbill
1monthLIBOR

Bunds,CETES,swaps,etc.

WhatsaFuture?
Futuresarelikeforwards:Inbothcontracts:
Oneparty(long)agreestobuysomethingfromacounterparty
(short)onsomedateinthefuture
Thedetailsoftheitemthatshortwilldelivertolong(whatit
is,howmuchofit,whereitistobedelivered),arespecified
Theprice(forwardpriceorfuturesprice)thatlongwillpayto
shortwhenthecontractmaturesisspecified
Valueofthecontractatinitiationiszero
Netsupplyiszero

Futuresvs.Forwards
Futures
Standardized
Exchangetraded
Clearinghouse
Margin
Dailyresettlement

Forwards
Customized
OTC
Bilateralcontracts
Nomargin
Settlementatmaturity

Markingtomarket
Futurescontractsareresettledeachdaybasedonthe
closingfuturesprice.
Ifthefuturespricehasrisenduringthetradingsession,the
clearinghousecollectsfromshortandpaystolong.
I.e.,contractvalueisresettozeroattheendofeachday.

Marginispostedtoinsurethatanycashneededfor
dailyresettlementsisavailable.
Bothmarginandmarkingtomarkethavecashflow
consequencesthataredifferentfromforwardcontracts.

Margin
Initialmargin:amountrequiredtooriginatea
futuresposition.
Maintenancemargin:minimumamountneededto
maintainafuturesposition.

Ifthebalanceofthemarginfallsbelowthislevel,amargin
callisissued.

Variationmargin:amountrequiredinamargincall.

Ifatraderfailstomeetamargincallpromptly,their
positiongetsliquidated.

Example:PeoplesSavings
Peoplesfundeditsmortgageloanportfolio
withretailCDsthatreseteveryquarter.
TheirCDswerepricedafixedspreadoverthe
threemonthTbill.
InlateMay1982,theywereconcernedthatbill
rateswouldriseoverthenextseveralmonths.
Problem:TheirSeptemberrefundingwouldbe
expensiveandresultinlosses.

Example:PeoplesSavings
Solution:Tbillfutures
TbillfuturesaretradedontheCME
Deliverable:$1,000,000facevalueof13week
bills
Futurespricequotedas:

F = 100 * (1 d f )
Wheredfisthefuturesbillrate

Example:PeoplesSavings
Thisindexpricemovesinthesamedirectionas
billprices(oppositedirectionfromrates)
Longbenefitswhentheindexpricerises

Onetickinthismarketis.01,oronebasis
point
Minimumpricemoveis1/2tick($12.50forthe90
daybill)

F = 100 * (1 d f )

Example:PeoplesSavings
Indexpriceisnotabillprice
Fisthefuturesindexprice
tisthenumberofdaysfromsettlementtomaturity
ofthedeliverablebill
Usually91,butcouldbe90,or92

t F
Pf = 100 * 1
1

360 100

Example:PeoplesSavings
Forexample,iftheindexpriceis92.52,andthe
deliverablebillisa90daybill,then
92.52
d f =1
= 7.48%
100

90

Pf = 100 * 1
.0748= $98.13

360

Multiplythisby10,000togettheinvoicepriceonsettlement

Example:PeoplesSavings
BacktoPeoplesproblem:Howtoprotectthe
bankagainstanincreaseinitsfundingcosts.
Buyorsell?Longorshort?
OnMay20,theysold400SeptemberTbill
futuresatafuturesindexpriceof88.58.
Theypostedinitialmarginof$1,000,000
($2,500x400)
Whathappened?

Example:PeoplesSavings
Whathappenedtorates?
92
91

Futures Price

90
89
88
87
86
85
84

Example:PeoplesSavings
Thedreadedmargincalls
92

$9,000
Futures Price

91

$8,000

Balance
$7,000

90

$6,000

89

$5,000
88
$4,000
87

$3,000

86

$2,000

85

$1,000

84

$0

Example:PeoplesSavings
Thedreadedmargincalls
$9,000
$8,000
$7,000
$6,000
$5,000

Balance
Cumulative

$4,000
$3,000
$2,000
$1,000
$0

Example:PeoplesSavings
ItsnowAugust20.Elevenmoredaysuntil
September1.
Thebankisoutover$3,000,000inmargin.
Whatshouldtheydo?

Example:PeoplesSavings
Sticktotheirguns:Tonothedgeistospeculate
AssumeTbillstradeat8.0%on9/1
Lossonfuturesposition:

(88.58 92.00)($2,500)( 400) = $3,420,000

Gainfromlowerfinancingcosts:

11.42%

8.00%

($400,000,000) = $3,420,000

Example:SoutheastCorp
Southeastwasgoingtoissue$60millionof
bonds(ratedAa)inAugust
InJanuary,bondrateswereattractiveat
12.88%
WhatisSoutheastCorpsexposure?
Howmighttheyhedgetheexposure?
CanSoutheastlockinaborrowingratenow?

Example:SoutheastCorp
Thesolution:Tbondfutures
TbondfuturesaretradedontheCBOT
Deliverable:ahypotheticalTbondwith
$100,000offacevalue
A6%coupon
Atleast15yearstofirstcallormaturity

Contractisquotedaspercentofparin1/32s
($31.25percontract)

Example:SoutheastCorp
AnyTbondthathasatleast15yearstofirst
callisdeliverableintothefuturescontract
Shortchooses:
Whichbondtodeliver(qualityoption)
Wheninthedeliverymonth(timingoption)
Maydeliverafterfuturespriceisdetermined(wild
cardoption

Example:SoutheastCorp
Tomakevariousbondsequivalent(almost),
CBOTusesconversionfactorsforeachbond
Theconversionfactoris,roughly,thepriceof
thebond($1facevalue)if
Itsyieldtomaturity,
calculatedfromthefirstdayofthedeliverymonth,
equals6%

Theexactformulaisugly,soIvecodeditinthe
spreadsheetTbondFut.xlsforyou.

Example:SoutheastCorp
Example

T-bond Futures
Conversion Factor Calculator
Coupon
Maturity Date
First Delivery Date
Time to Maturity:
Years
Months
Months (to Lowest 3)
Total Quarters
Full Semesters
Remainder
Conversion Factor

8.000%
11/15/21
9/1/05
16
2.47
0
64
32
0
1.2039

Example:SoutheastCorp
Theadjustmentisnotperfect,however.
$200.00

P6,15
PDel

$180.00
$160.00
$140.00
$120.00
$100.00
$80.00
$60.00
$40.00
$20.00
$0.00

Example:SoutheastCorp
Forthisreason,oftheavailablebonds,there
willbeacheapesttodeliver
Thecheapesttodeliverbondisthebondhaving
thelowestBAC(basisaftercarry)
Basisis

Bt = Pt cf Ft,T

Example:SoutheastCorp
BACisthisbasisless
Reinvestedcashflowsreceivedfromholdingthe
bond
Plusfinancingcosts

Againtheformulaisugly,soIveprovidedan
exampleinTbondFut.xls

Example:SoutheastCorp
BacktoSoutheastshedgingproblem
Southeastwantstohedgeitsissuanceof$60
millioninAabondsusingTbondfutures.
SellorbuyTbondfutures?Howmuch?
Dollarequivalenthedgeratio:

Example:SoutheastCorp
ThechangeinthevalueofSECsspotposition
willbe

V spot = $60M PAa

h

Example:SoutheastCorp
ThechangeinthevalueofSECsfutures
positionwillbe

V futures = $100K P f

h

Example:SoutheastCorp
Giventherelationshipbetweenthefutures
price,theconversionfactor,andTbondprice:

$60M PAa
PAa
h=
= 600
cf
P T
P
T
$100K
cf

Example:SoutheastCorp
Todeterminetheratioofpricechanges,recall
thatdurationis

Example:SoutheastCorp
Usingthisdefinitionofdurationandalittle
algebragives

DAa

DT

Example:SoutheastCorp
Fromwhichweget

PAa D Aa P Aa 1 + y T y Aa
=

PT
DT
PT 1 + yAa yT
7.8 100
1+.118

1.123
18
8.5 101 32 1+.1288

Example:SoutheastCorp
Whichgives

PAa
= 1.00495555
PT
Or

h = 600 1.00495555 cf

Example:SoutheastCorp
ThecffortheCTDbondwas1.422,so

Example:SoutheastCorp
SECsellsforwarda12%Tbondwith233/4yearsto
maturityatapriceof$69.25x1.4222=$98.4735.
Atthisprice,thebondyields12.2%
GiventherelationshipbetweenAayieldsand
Treasurys,thisimpliesaborrowingcosttoSECof

.5808 + 1.123(12.2%) = 13.12%